In my last post I mentioned that I wanted to pass along some of the things I’ve learned about money in the last year. To give some background, when I got married about a year ago I realized that my wife and I were facing some pretty serious debt from student loans and a couple credit cards. We took Dave Ramsey’s Financial Peace University class and began to change how we handled our money. Two days ago we calculated that since June of this year, we’ve paid off around $8,000 of our debt. We still have a very long way to go (We are shooting to be done with debt by December of 2015) but it was so encouraging to see how much progress we are making. We actually could have paid off a full $10,000 but we have taken that extra money and put it aside until Antonia’s job situation is more secure. (She’s a government contractor and her contract expires in a couple months.) So that’s a rate of around $10K per 6 months. Right now together we make about $80K per year just to give you an idea of the income we’re working with.
There are a few things I’ve learned since trying to turn around my finances that surprised me. A few things I assumed were true turned out to be harmful for my ability to save money. The first one I’m going to share involves your Credit Score.
I can remember sometime in high school being told by someone in my family that I should consider getting a credit card soon because it would help me to begin building my credit. Luckily I held off on getting a credit card until I was almost done with college, but ever since they told me that I had it in my head that it was true. That idea was reinforced by other people over the years as well as catchy jingles on TV for free credit check websites. In fact, if you watch that video, you’ll be bombarded with the dangers of a bad credit score in the first 10 seconds. “Now we can’t get a loan for a respectable home.” Bad credit score equals bad life.
Well, here’s what we need to understand about credit scores: Yes, they are important when it comes to getting loans. But you actually cannot even HAVE a credit score without FIRST having a loan (credit cards count as loans) and you can’t KEEP a GOOD credit score without CONTINUING to take out loans. Ok, does everyone understand what I just said? You CAN NOT have a good credit score without being in debt. You also CAN NOT have a great credit score without MAINTAINING debt. Here is a link to the breakdown of a FICO score.
I need to acknowledge that this is a bit of a controversial idea. The manager at Wells Fargo once asked me if I wanted to open a line of credit to act as overdraft insurance. I told him I was trying to get rid of all of my lines of credit. He looked at me as if I was a member of a cult and he nicely told me it was a dangerous idea that I was following. His argument (and the argument of many people) was this: He agreed that it was bad financial advice to tell someone to keep a balance on a credit card because of the interest, but to not have any would destroy your credit score which would destroy your ability to borrow. He offered me a scenario: ‘What happens if your roof collapses and you need a $2000 loan to fix it? The best thing to do is use a credit card for small things like McDonalds and just pay it off at the end of the month so you maintain good credit but don’t pay interest.’
That is how most financially savvy people handle their credit score and I totally agree that it’s possible to live that way and not find yourself incredibly deep in debt (as long as you are very careful). However, that doesn’t change my opinion and here’s why:
First of all, what would happen to credit card companies if everyone were to live this responsibly? They would be handing out free loans to everyone without making any money and therefore they would go out of business. Do you think credit card companies are shaking in their boots over the advice that the Wells Fargo guy gave me? They aren’t, but I want to talk about credit cards in a later post. I want to focus just on the credit score today.
Let’s pretend that I had gone all the way through college without taking out student loans and without ever having a credit card. Crazy talk, right? Debate that all you want, but I had the choice to go to community college and work, but I didn’t. It’s important to understand that if you don’t have any debt, you don’t have a ‘bad credit score’ you have NO CREDIT SCORE. It can’t be calculated without debt. So when a company searches your name, they get an error message. Anyway, let’s say that I came out of college without any debt, what would I do if my roof collapsed? Well, I started out telling you that in 6 months, $10,000 of our money went to savings and towards our debt. Everyone, please imagine a world where you get to actually keep the money that you earn. It’s incredible what you could do with your money if you were able to keep it and you were actually disciplined with it. If we didn’t have debt (which could have been possible if I had made different choices), then in 6 months we could have saved up $10,000 to take care of any emergencies that came our way. Then 6 months later we could have had $10,000 to buy a car in cash and not live with car payments. 6 months later we could have had $10,000 to enjoy a nice vacation without paying interest on credit cards to pay for it. So in 1 1/2 years we could have had a strong emergency fund, a nice paid-for car and a vacation to wherever we want!
My overall point here is not to tell you that credit scores don’t matter. They do. If I didn’t have a good credit score, but also wasn’t good at saving, I’d be in trouble. My point is very simply that your end goal should NOT be to have a good credit score. It should be to establish yourself without debt so that you can save up enough money to take care of your own emergencies. It wasn’t that long ago that common wisdom was to save money for a rainy day. Who do you think is responsible for the shift towards credit score dependance? I can tell you that it’s not a system designed to help you become wealthy.
There’s a lot more to the topic than what I’ve said here. Like, for example, your auto and home insurance rates are generally higher if you don’t have a credit score. That’s inconvenient and arguably wrong, but I’d still rather pay more money in insurance than pay all the interest for debt that it would take to have a good credit score. Also, it is possible to manually underwrite a mortgage which means you wouldn’t need a credit score to get one. That’s my opinion and hopefully I’ve given you a different way of thinking about it so that you don’t just go along with the assumption that you must build your credit. I’d encourage you to do your own research and I’ll even give you some links:
I’m by no means an expert on money, but if you want to challenge me, change my mind or ask me a question in the comments I will try to respond.